MACROECONOMIC POLICIES, GROWTH, AND WELFARE IN A STOCHASTIC ECONOMY

An integrated stochastic equilibrium growth model is constructed and directed to various questions pertaining to monetary and tax policy. Two main issues addressed include: (i) the tradeoff between the rate of capital accumulation and inflation in a stochastic environment; (ii) economic welfare and optimal policy making. The key result is that policy variables impact on welfare through their effect on the after-tax nominal interest rate, which therefore serves as an intermediate policy target. The welfare maximizing interest rate target is derived and we discuss its attainment through appropriate monetary and tax policies. Tradeoffs between policy instruments are also addressed.